Coronavirus: Preventing a new banking crisis

Targeted European measures have to counteract a contagion of the financial sector

European countries and institutions should provide liquidity to companies that are economically affected by the new coronavirus Covid-19. According to a position paper by several international financial experts around the Leibniz Institute for Financial Research SAFE in Frankfurt, the liquidity shortfall in the real economy caused by virus-related cashflow interruptions could otherwise lead to a new banking crisis. Only coordinated fiscal policy measures have the potential to reduce the default risks of banks and thus stabilize the financial system. Monetary policy measures, on the other hand, are unlikely to mitigate cash liquidity shortages at the level of individual firms.

The coronavirus has a substantial impact on economic activities worldwide. In a SAFE Policy Letter the authors point out that looming insolvency of firms increasingly stress the banks as creditors. In order to reduce the banks' risks, governments should take timely measures to prevent insolvencies during the corona epidemic. The authors include Arnoud Boot (University of Amsterdam), Elena Carletti (Bocconi University), Rainer Haselmann (Goethe University Frankfurt), Hans-Helmut Kotz (Harvard Center for European Studies and SAFE), Jan Pieter Krahnen (SAFE), Loriana Pelizzon (Goethe University Frankfurt and SAFE), Stephen Schaefer (London Business School), and Marti Subrahmanyam (NYU Stern Business School).

Beyond national measures, coordinated action at European level is decisive to prevent markets from losing confidence in the resilience of banks, particularly in countries with limited fiscal capacity. In contrast to the euro crisis of 2011, the cause of the current crisis does not lie in the financial markets; therefore, the risk of moral hazard for banks or states is low, according to the experts. They recommend targeted action at the European level, for example along the model of the German Kurzarbeit-scheme. Furthermore, supranational European financial institutions like the European Investment Bank or the European Bank for Reconstruction and Development should play an important role in supporting affected companies during the crisis phase.

SAFE Policy Letter No.78: The Coronavirus and Financial Stability